Breaking Down Breakage

By HMI Performance Incentives

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Are you someone who typically spends your reward points, or saves them? Between your credit cards, frequent flyer miles and hotel points, how many points do you currently have stashed away for that future trip or experience? Loyalty points, often go untouched, even though it seems like there are numerous articles telling us to do so. 

Nevertheless, there the points sit, waiting to be redeemed for when the right opportunity comes along. And what does this inactivity say about the points’ owner? What does it tell the brands you’re supposedly loyal to about that very loyalty? This, as it turns out, is a common question in incentive and loyalty programs, and it’s one that centers on the topic of breakage.

What is breakage? In a nutshell, it is the outstanding liability of a reward, either in terms of points or dollars and cents. In an incentive or loyalty program, it refers specifically to the amount of program currency that a participant earns but hasn’t yet redeemed. 

The concept of breakage seems relatively straightforward and easy to understand, but its applications and interpretations can actually be a bit more nuanced. With that in mind, let’s look under the hood to see how breakage works within an incentive or loyalty program.

In a typical points program, points are paid for either on issuance or redemption. If it’s on issuance, the points are bought and paid for as participants earn them—in other words, the client pays for them upfront, regardless of whether the participants end up actually using them. 

In the case of redemption, the points are only paid for when a participant earns the points AND spends them on some kind of reward. In our experience, nine out of 10 clients will choose to structure their program this way, and the main reason is that they feel they can benefit from this program breakage. Again, when points are paid for on redemption, clients are only required to pay for those points that are used, not just earned. But in almost any program, participants will earn points that they don’t end up spending— how often do you see “0 points” in your hotel or frequent flier accounts? This remaining balance is the program’s breakage.

Each form of payment structure has pros and cons, but before we touch on that, it’s important to understand some key factors of breakage, because it’s these factors that will help you determine which payment structure to use for your program.

Breakage: Key Factors

1) There will always be some breakage

When discussing this topic with clients, we try to make it clear that breakage can and will occur. A 100% redemption rate for most programs with size and/or length is practically unheard of; in most cases you will almost never see ALL of your participants redeeming ALL of their points ALL of the time. In fact, on average we tend to see roughly an 80% redemption rate across all of our programs.

This factor is key because if you fail to account for this breakage in your financial models, it can throw off your accounting and cause you to make choices in your program structure that may hinder its long-term success. 

2) Breakage tends to decrease as a program matures

Program length can be a significant factor in understanding breakage. Typically, a program that’s just launched is going to have a lower redemption rate in its first year than it will in subsequent years. The main reason for this is a lack of familiarity with the program. As participants become more familiar with the program structure, how they can earn and redeem, what rewards are offered, etc., they tend to become more engaged with it, paying more attention to their program accounts and using their points on a more consistent basis.

With that said, you may still see breakage in longer-term programs. Participants may be saving up for a larger, more aspirational reward, or they may simply be waiting for the right time to utilize their points. 

3) The “how” and “when” of distributing points can affect breakage

In addition, how and when participants earn points also plays a key role in program breakage. For example, if your program provides points on a per-dollar basis, this may lead to a lower redemption rate because the point total increases will be more gradual, leading to fewer checks and redemptions. In other words, with a loyalty program, in which participants earn points for each purchase or each sale, they will usually accrue these points more slowly and incrementally. As an example, how often do you go out of your way to check the points balance you’ve accumulated from your credit card?

On the flip side, if your program awards points on a goal-achievement basis, your participants may suddenly see large point totals deposited into their accounts. This could lead to large spikes in redemptions at certain times of the year, which could impact your accounting and the timing of when you would count the breakage. 

This can also apply to gift card programs, which can see more steady redemption rates because participants will often redeem their gift cards, which are often dispensed in batches and so there is no need (or ability) to save up. 

Lastly, if your program requires claims or has an eLearning component that requires more active participation, you are also likely to see a higher redemption rate. This is due to the fact that these types of programs tend to produce greater participant engagement.

4) Loyalty programs vs. incentive programs vs. short-term promotions

Another thing to consider with breakage is whether you’re running a loyalty program, an incentive program, or a short-term promotion. In a loyalty program, a high breakage rate may signal that something is wrong with your program, possibly with the user interface, the rewards catalog, or the program structure. Whatever the cause, significant breakage in a loyalty program tends to signal a lack of engagement and a perception that points are not valuable. This will, of course, depend on the rewards being offered (see below), the length of the program (see above), and whether or not your points have an expiration date on them.

In an incentive program, breakage may not be quite as alarming. Incentive programs tend to be goal-based, and as we touched on earlier, this type of program structure may lead to lumpy point deposits and accruals. In these cases, you may see some of your participants with significant points balances, but it’s important to keep in mind how close they are to achieving their next goal. Perhaps they’re holding onto their points until then so that they can redeem them for something bigger. Of course, if you’re seeing a rollover of this breakage from one year to the next, it could be a cause for concern. 

Lastly, you may notice a high redemption rate from standalone short-term promotions. That’s because there may be a “use it or lose it” component that drives participants to earn points and quickly redeem them before the promotion is over. The rewards catalog for this type of event might also feature mostly smaller items that don’t require participants to save up their points. (See below)

5) The types of rewards matter

As we’ve mentioned, the types of rewards you offer will have a big effect on the amount of program breakage. For example, if your catalogue contains mostly small-denomination merchandise rewards or gift cards, you’ll likely see less breakage than if you’re offering higher-end items, experiences, or travel rewards. For obvious reasons, these larger rewards will necessarily require a longer time horizon for which participants will need to save up their points—this may lead to greater fluctuation in breakage levels, which is something you and your finance team will want to consider as you build out the overall program structure. 

6) Issuance vs. redemption

Now, let’s return to the question of whether to pay for points on issuance or redemption. While most clients opt to pay on redemption, there is one major benefit to paying on issuance. When it comes to the accounting of a program, paying for points on issuance is much neater and more straightforward on a balance sheet. Especially for a publicly traded company that may need to disclose its P&Ls on a quarterly basis, identifying the black-and-white cost of a program up-front may be helpful, if not necessary. 

On the other hand, if the program is billed on redemption, the points will still need to be accounted for when they’re earned, even if they’ve not yet been invoiced. This means that if you do choose to pay for points on redemption, you’ll need to be extremely focused on the program analytics. You’ll have to do a good job of estimating your program breakage and structure your program in such a way that enables clear forecasting of program participation. What you don’t want is for your finance team to prepare for an 80% redemption rate, only to see your participants end up redeeming 90% of their points. In this situation, you may need to go back to your organization for more program funding, which can be tricky. “Our program was TOO effective” should never be a cause for concern. In the end, the choice is largely a financial one, but it will require some forethought because whatever decision you end up making, this may have a cascading effect on your program structure and the decisions you make about it.

Recommendations

Finally, below are some quick Dos and Don’ts for how to think about and handle breakage in your program:

• DO assume that breakage will occur in your program, and factor this into your up-front accounting. Don’t pinch pennies on rewards or make the rewards structure less achievable simply because you assume everyone will redeem the points that they’ve earned. They won’t. 
• DON’T include an aggressive expiration date for the redemption of points. In our experience, this short-term “use it or lose it” approach can actually end up hurting motivation and engagement in a program and can limit the success of your program long-term. Instead, DO allow participants to accumulate and save up their points for bigger, more aspirational rewards that will keep them coming back to the program “well” over time.
• DO arrange an annual assessment or clean-up of your program to help you get a clearer picture of your program’s breakage and thus simplify things for your finance team. This might include scanning your participant list and removing people who are no longer with the company or enrolled in the program.
• DON’T panic if your program ends up with significant breakage. Again, this isn’t necessarily a red flag for your program. However, it may be cause for a deeper investigation into why participants aren’t spending their points. Is it because participants don’t understand the rules of the program? Or that they don’t see its value? Does your program need better marketing? In the event of high program breakage, DO analyze the data of who is and isn’t redeeming their points, what rewards are being redeemed for, etc. In some cases, it might also help to solicit information directly from the participants themselves through a survey that asks them whether or not they’re redeeming their points, and why.
  
  

Conclusion: Breakage and Program Health

So, is breakage a good thing or a bad thing? As you might imagine, the answer is, that it depends. As we mentioned, breakage in a loyalty program could be a bad sign, but it is also a natural side effect of an incentive program. On the one hand, low program breakage generally signals high participant engagement, which clearly is a good thing. On the other hand, however, if participants have redeemed all of their points, they may not have that “carrot” that brings them back to their account as frequently as they might otherwise if they had a consistent points balance. 

At the end of the day, breakage is a liability on the balance sheet, so it needs to be understood and accounted for. As program managers, we view it as a barometer of program health, because it highlights the degree to which participants are earning points, collecting points, and redeeming points, all of which are positive signals about your program’s underlying effectiveness. 

With that being said, these figures are something worth continually monitoring. A high score tells us and our clients that the program is effective and working as expected, while a low score may indicate a need for intervention from one of our incentive experts.

While breakage isn’t always a concept that’s well understood or a top priority when it comes to program planning, in our experience, it’s definitely a topic worth considering, and a key factor to consider when running a program. If nothing else, keep in mind that not all points will always be redeemed, and not all award earners will redeem. Ultimately, it’s the degree to which these occur that can have a big impact on a number of important program decisions.